Decisions, Decisions

We all find ourselves in situations that call for strategic thinking. Business executives plan strategies to gain market share, to respond to their competitors' actions, to handle relations with employees, and to make career moves. Managers in government think strategically about the likely effects of regulations at home and of diplomatic initiatives abroad. Generals at war develop strategies to deploy troops and weaponry to defeat the enemy while minimizing their own losses. At a more individual level, buyers and sellers at flea markets apply strategies to their bargaining. And parents use strategy on their children, whoof coursebehave strategically with their parents.

What is strategy? Essentially, it is anticipating the actions of another individual and acting in ways that advance one's self-interest. Since the other person also behaves strategically, strategy includes making assumptions about what that individual believes your strategy to be. Probably the most common use of strategy occurs in basic economic transactions, such as buying and selling. However it is applied, the ultimate point of strategy is to achieve objectives.

That is precisely what players of games try to do. Similarities between games and strategic behavior in the economy formed the framework for Theory of Games and Economic Behavior, a book published in 1944 by mathematicians John von Neumann and Oskar Morgenstern. Their landmark work begins where classical economics leaves off.

The starting point for traditional economics is the equilibrium price, the point at which a seller's asking price equals the buyer's bid price. Classical economic theory goes on to analyze the price in terms of outside influences. Von Neumann and Morgenstern, however, went in another direction: They looked at the relationship between the participants.

Exactly how, they asked, do buyers and sellers get to the equilibrium price? In a world of perfect competition, containing so many buyers and sellers that any one individual's acts are insignificant, marketplace dynamics suffice. But what about economic transactions that involve only a few buyers and sellers? What happens when, for example, MCI offers potential customers a deal on long-distance service, and AT&T responds by offering the public its own new deal? The strategic moves in such economic decision making struck Morgenstern and von Neumann as mathematically indistinguishable from moves in chess, poker, and other games in which some strategies consistently win over others. Their book, a compendium of mathematical theorems embodying many different strategies for winning, was the first rigorously scientific approach to decision making.

Significant as it was, game theory took a long time to catch on. A small group of academics recognized its significance as a research tool. And some military applications appeared in the 1950s, when the Rand Corporation used game theory to anticipate responses of potential enemies to weaponry of various kinds. The world of business, however, regarded game theory as an arcane specialty with little practical potential.